Sen. Brown Pushes Crowdfunding Legislation

You know when you hear about the latest hot IPO with an initial share price that breaks through the stratosphere? It’s hard not to think, “Why couldn’t I have been an early investor in that startup?”

Well, Sen. Scott Brown wondered the same and has filed legislation in the Senate that could change the way startups are funded. WBUR business and technology reporter Curt Nickisch joined Radio Boston to discuss Brown’s proposals.

Meghna Chakrabarti: So Brown has a plan to change the way startups are funded. How?

Curt Nickisch: Well, let’s be clear: the U.S. House of Representatives overwhelmingly passed a so-called crowdfunding bill in November. It was only the day before that vote that Brown filed a similar bill in the Senate. So it’s not his invention, but Brown has been pushing hard for it. Here’s what he said Monday:

This is something that is a great opportunity to think outside the box and modernize and provide additional opportunities for investment and job creation.

And basically, what crowdfunding does is allow a small business or startup to raise a little bit of money from a lot of people, maybe $1,000 a person.

How does this differ from something like KickStarter?

Equity ownership. KickStarter, for anyone who doesn’t know, lets people ask for donations – and mostly for design, music, arts-related stuff. KickStarter is on track to raise as much money this year as the National Endowment for the Arts will give away. So it is a powerful tool. The difference is, under these crowdfunding bills, you’re not donating to a small company or startup, you are buying shares in the that company. You’re an investor.

The status quo in business says that only “accredited” or sophisticated investors should make these initial investments because they have the risk tolerance, and information available to make informed choices. How would individual investors be able to come by that same information?

That’s something that Brown’s bill does that the House version does not. And that is require that intermediaries act as a sort of clearinghouse for crowdfunded investments. The idea is: the same way eBay matches buyers and sellers and gives reputation points and tries to cut down on fraud, Brown envisions regulator-approved intermediaries that would vet these business ideas to some extent before they can go to individuals for money.

Potential fraud and abuse has to be an issue here. How would individual investors be protected from that?

Well, that’s a balancing act that these competing bills are trying to figure out. Brown’s isn’t the only one in the Senate. What they don’t want is someone to raise money for tools for a plumbing business, for example, and then go to Mexico and say he didn’t get any orders. So you have to protect against that, you have to provide ways for investors to recoup losses when it’s fraud. On the other hand, Harvard Business School professor Bill Sahlman says you don’t want to put in too much protection, either:

Trying to protect people against fraud can become so onerous that no activity takes place. Trying to limit the risk to which all investors are exposed can drive out all investment.

Sahlman says there needs to be failures for there to be successes, and he says the big job in Congress is finding this line between fraud and failure.

So only very few startups end up being Facebook. It’s a risky business. Shikhar Ghosh, another professor at Harvard Business School, says that some 40 percent of all startups tank, meaning they liquidate all their assets and investors lose every penny. How do local entrepreneurs feel about this bill?

That’s the tricky thing about this, is that in a way, it can bring a community closer to its companies. Right now most of us invest by putting our money in mutual funds that have stocks of companies we have no relation to. So there’s an interesting social change here almost. But mostly, entrepreneurs are happy about this because it gives them another way to fund an early-stage idea. To try something out, see if it sticks. And so while no one wants to fail, they’re happy to have the chance to give it a shot.

How are traditional venture capitalists and investors responding? Do they see the bill as a threat to their early-investor advantage?

No, not really. It does get into their territory somewhat. But certainly not all venture capital firms do early stage investing that crowdfunding is probably the best fit for. And also, many angel investors and venture capitalists are looking for the home run. There might be businesses out there that will be fine little businesses, but they’re not going to be huge either. And so a lot of venture capitalists stay away from those, it’s not worth their time. But that doesn’t mean they’re not good investments and that they won’t create jobs. And that’s why crowdfunding, for the right companies, could be a great tool.

Why is Brown taking such an active role in this issue?

Jobs are obviously the election issue. The senator has been for reducing regulations to make it easier for businesses to grow. This is an example of that. It changes federal law to lower the barrier for investing.

It’s also a great fit for him politically in Massachusetts because the tech sector here is a real hotbed for this activity. And remember a lot of these are Internet companies, even though we’re in a Democratic state, the Internet has a free-thinking, almost-libertarian streak to it. So it’s a good fit on a number of levels.